[Federal Register Volume 61, Number 57 (Friday, March 22, 1996)]
[Notices]
[Pages 11913-11929]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-6970]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36980; File No. SR-NASD-95-63]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
Regulating the Conduct of Broker/Dealers Operating on the Premises of a
Financial Institution
March 15, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``1934 Act''),\1\ notice is hereby given that on December 28, 1995,
the National Association of Securities Dealers, Inc. (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II, and III below, which Items
[[Page 11914]]
have been prepared by the NASD. The filing was subsequently amended on
January 24, January 29 and March 7, 1996.2 The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
\1\ 15 U.S.C. 78s(b)(1).
\2\ See Letters from Elliott R. Curzon, Associate General
Counsel, NASD, to Mark P. Barracca, Branch Chief, Division of Market
Regulation, SEC (January 24, 1996 and March 7, 1996) and Letter from
Suzanne E. Rothwell, Associate General Counsel, NASD, to Mark P.
Barracca, Branch Chief, Division of Market Regulation, SEC (January
29, 1996). This notice reflects those amendments. The text of the
amendments may be examined in the Commission's Public Reference
Room.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The NASD is proposing to add a new section specifying requirements
for broker/dealer conduct on the premises of a financial institution.
Below is the text of the proposed rule change.
RULES OF FAIR PRACTICE
Broker/Dealer Conduct on the Premises of Financial Institutions
Sec. ____________.
(a) Applicability
This section shall apply exclusively to those broker/dealer
services conducted by members on the premises of a financial
institution where retail deposits are taken. This section does not
alter or abrogate members' obligations to comply with other applicable
NASD rules, regulations, and requirements, nor those of other
regulatory authorities that may govern members operating on the
premises of financial institutions.
(b) Definitions
(1) For purposes of this section, the term ``financial
institution'' shall mean federal and state-chartered banks, savings and
loan associations, savings banks, credit unions, and the service
corporations required by law of such institutions.
(2) ``Networking arrangement'' and ``brokerage affiliate
arrangement'' shall mean a contractual arrangement between a member and
a financial institution pursuant to which the member conducts broker/
dealer services for customers of the financial institution and the
general public on the premises of such financial institution where
retail deposits are taken.
(3) ``Affiliate'' shall mean a company which controls, is
controlled by or is under common control with a member as defined in
Schedule E of the By-Laws.
(4) ``Broker/dealer services'' shall mean the investment banking or
securities business as defined in Paragraph (l) of Article I of the By-
Laws.
(5) ``Confidential financial information'' shall not include:
(A) customers' names, addresses, and telephone numbers, unless a
customer specifies otherwise; or
(B) information that can be obtained from unaffiliated credit
bureaus or similar companies in the ordinary course of business.
(c) Standards for Member Conduct
No member shall conduct broker/dealer services on the premises of a
financial institution unless the member complies initially and
continuously with the following requirements:
Setting
(1) Wherever possible, the member's broker/dealer services shall be
conducted in a physical location distinct from the area where the
financial institution's retail deposits are taken. In all situations,
members shall identify the member's broker/dealer services in a manner
that is clearly distinguished from the financial institution's retail
deposit-taking activities. The member's name shall be clearly displayed
in the area in which the member conducts its broker/dealer services.
Networking and Brokerage Affiliate Agreements
(2) Networking and brokerage affiliate arrangements between a
member and a financial institution must be governed by a written
agreement that sets forth the responsibilities of the parties and the
compensation arrangements. The member must ensure the agreement
stipulates that:
(A) supervisory personnel of the member and representatives of the
Securities and Exchange Commission and the Association will be
permitted access to the financial institution's premises where the
member conducts broker/dealer services in order to inspect the books
and records and other relevant information maintained by the member
with respect to its broker/dealer services;
(B) unregistered employees of the financial institution will not
receive any compensation, cash or non-cash, that is conditioned on
whether a referral of a customer of the financial institution to the
member results in a transaction; and
(C) the member will notify the financial institution if any
associated person of the member who is employed by the financial
institution is terminated for cause by the member.
Compensation of Registered/Unregistered Persons
(3) The member shall not provide cash or non-cash compensation to
employees of the financial institution who are not registered with an
NASD member in connection with, but not limited to, locating,
introducing, or referring customers of the financial institution to the
member.
Customer Disclosure and Written Acknowledgment
(4) (A) When a customer account is opened by a broker/dealer on the
premises of a financial institution where retail deposits are taken,
the member shall disclose, orally and in writing, that the securities
products purchased or sold in a transaction with the member:
(i) are not insured by the Federal Deposit Insurance Corporation
(``FDIC'') or other applicable deposit insurance;
(ii) are not deposits or other obligations of the financial
institution and are not guaranteed by the financial institution; and
(iii) are subject to investment risks, including possible loss of
the principal invested.
(B) For all accounts opened by a broker/dealer on the premises of a
financial institution where retail deposits are taken, the member shall
make reasonable efforts to obtain from each customer during the account
opening process a written acknowledgement of the disclosures required
by Subsections (c)(4)(A) (i) through (iii).
Use of Confidential Financial Information
(5) The member shall not use confidential financial information
provided by the financial institution regarding its customer unless
prior written approval has been granted by the customer to release the
information.
Communications With the Public
(6) (A) All member communications regarding customers' securities
transactions and long and short positions, including confirmations and
account statements, must indicate clearly that the broker/dealer
services are provided by the member. Communications that include
information regarding non-deposit-insured transactions and positions
with the member and deposit-insured transactions and positions or
accounts with the financial institution should distinguish clearly
between the two. Securities transactions conducted by the member should
be introduced with the member's identity and, at a minimum, the member
must disclose that
[[Page 11915]]
securities products: are not insured by the FDIC or other applicable
deposit insurance; are not deposits or other obligations of the
financial institution and are not guaranteed by the financial
institution; are subject to investment risks, including possible loss
of the principal invested.
(B) Advertisements, sales literature, and other similar materials
issued by the member that relate exclusively to its broker/dealer
services will be deemed to be the materials of the member and must
indicate prominently the identity of the member providing the broker/
dealer services. The financial institution may be referenced in a
nonprominent manner in advertising or promotional materials for the
purpose of identifying the location where broker/dealer services are
available and, where appropriate, to disclose a material relationship
between the member and the financial institution, for example, where
the member is affiliated with a financial institution that serves as
investment adviser to an open-end investment company (``mutual fund'').
(C) Advertisements, sales literature, and other similar materials
jointly issued by the member and a financial institution that discuss
services or products offered by both entities must distinguish clearly
the products and services offered by the financial institution from
those offered by the member. The name of the member must be displayed
prominently in the section of the materials that describes the broker/
dealer services offered by the member, which section will be deemed
materials of the member.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
(1) Background
In recent years, banks, savings and loan associations, credit
unions and similar financial institutions not registered as a broker/
dealer under the 1934 Act (``financial institutions'') have expanded
their business into retail securities sales. These institutions
generally conduct such activities through affiliated broker/dealers or
non-affiliated broker/dealers operating under a brokerage affiliate or
networking arrangement. In addition, however, banks are exempt from the
definitions of the terms ``broker'' and ``dealer'' in Sections 3(a)(4)
and 3(a)(5), respectively, of the 1934 Act, and thus are not required
to register as broker/dealers when selling securities.
As these securities activities have expanded and financial
institutions have placed securities sales facilities in their retail
deposit taking areas, customers of the financial institutions have
become increasingly confused about the distinction between the insured
deposit products of the financial institution and the uninsured
securities products of the broker/dealer operating in the same
location.
In order to address this customer confusion problem, the NASD has
published several notices reminding members of their obligations under
the federal securities laws and the NASD's rules when selling
securities products to customers who may have little or no experience
with uninsured, non-depository products. In Notice to Members 91-74
(November 1991) and Notice to Members 93-87 (December 1993), the NASD
reminded members of their obligations to customers who were reinvesting
maturing certificates of deposit. In addition, in Notice to Members 94-
16 (March 1994) the NASD reminded members of their sales practice
obligations in connection with mutual fund sales and noted that the
growth of bank-affiliated and networking broker/dealers had focused
attention on the issue. Finally, in Notice to Members 95-80 (September
26, 1995) the NASD addressed additional concerns regarding member
obligations and responsibilities regarding mutual fund sales practices.
In Notice to Members 94-47 (June 1994) the NASD published the SEC's
November 24, 1993 no-action letter to the Chubb Securities Corporation
(the ``Chubb Letter'') concerning broker/dealer activity on the
premises of a financial institution. The Chubb Letter set forth the
requirements for networking broker/dealers as they related to customer
disclosure, compensation of employees of the financial institution,
promotional materials of the broker/dealer, location of the securities
activities of the broker/dealer, and inspection of books and records
with respect to financial institutions that are subject to broker/
dealer registration under Section 15(a) of the 1934 Act.
In addition, on February 15, 1994, the various financial
institution regulators 3 issued a joint statement titled the
``Interagency Statement on Retail Sales of Nondeposit Investment
Products'' (the ``Interagency Statement''). The Interagency Statement
established guidelines for financial institutions that sell securities
products to their customers, either directly or through networking or
affiliated broker/dealers. It is the NASD's understanding that, to the
extent securities are being sold by broker/dealers operating on
financial institution premises, NASD members are observing the
requirements of the Interagency Statement even though such broker/
dealers are not directly subject to the jurisdiction of the financial
institution regulators.
\3\ The Board of Governors of the Federal Reserve System
(``FRB''), the Federal Deposit Insurance Corporation, the Office of
the Comptroller of the Currency (``OCC''), and the Office of Thrift
Supervision (``OTS'') (``financial institution regulators'').
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The NASD has been concerned that the activities of member firms
operating on the premises of financial institutions and related
customer protection issues are not adequately addressed by existing
NASD rules and, because the Interagency Statement has no jurisdictional
reach to broker/dealers, there is no basis for NASD disciplinary action
against member firms that do not comply with the terms of the
Interagency Statement. Accordingly, the NASD is proposing to add a new
section to the Rules of Fair Practice to govern the conduct of broker/
dealers on the premises of financial institutions.
(2) Description of Proposed Rule
Applicability. Subsection (a) of the proposed rule provides that
the new section applies exclusively to broker/dealer services being
conducted by NASD members on the premises of a financial institution
where retail deposits are taken.
Subsection (a) specifies that the proposed rule covers financial
institutions that have an area ``where retail deposits are taken.'' The
NASD intends that the phrase ``where retail deposits are taken'' will
have its ordinary meaning; i.e., a financial institution with an area
where, with minimal limitations, the public (or members, in the case of
a credit union) can access the services of the institution. It would
not include financial institutions that do not generally provide access
to the public without an appointment, e.g., financial
[[Page 11916]]
institutions which solely provide trust services or private banking
services.
Subsection (a) also provides that the section only applies to
situations where broker/dealer services are conducted ``on the premises
of a financial institution where retail deposits are taken'' (emphasis
added). The proposed rule will apply to broker/dealer services provided
(including all accounts opened) in person by broker/dealer personnel on
the premises of the financial institution, as well as broker/dealer
services provided by telephone or other means of communication
(including computer terminals) by broker/dealer personnel on the
premises of the financial institution. The proposed rule change will
also apply to broker/dealer services provided by a broker/dealer via
the telephone or other means of communication to customers who are on
the premises of a financial institution even if the broker/dealer
personnel themselves may not be on the premises of the financial
institution.
If the broker/dealer is conducting business in a physically
separate location from the retail facility of the financial institution
and is not otherwise present on the premises of the financial
institution via computer terminal or other electronic communication,
the rule does not apply. For example, a broker/dealer operating in
separate office space on another floor or in another part of the same
building, even if the building is owned or primarily occupied by the
financial institution, and where the entrance to the broker/dealer's
office space is through the building lobby or an exterior entrance and
not through the financial institution's retail facility, the broker/
dealer will be considered to be conducting its services in a physically
separate location.
Subsection (a) also expressly states that the proposed rule does
not alter or abrogate the member's obligation to comply with other NASD
rules or the rules of other financial institution regulatory
authorities with respect to the member's operations on the premises of
a financial institution.
(3) Definitions
Subsection (b) of the proposed rule defines several terms used in
the proposed rule, such as, ``financial institution,'' ``networking
arrangement'' and ``brokerage affiliate arrangement,'' ``affiliate,''
``broker/dealer services,'' and ``confidential financial information.''
Each of the definitions are discussed below in connection with the
provisions of the proposed rule where they are used. The definition of
``financial institution'' applies only to the proposed rule change; not
to other provisions of the NASD's rules.
(4) Standards for Member Conduct
Subsection (c) of the proposed rule sets forth the specific
requirements for members doing business on the premises of a financial
institution as they relate to:
1. Setting;
2. Networking and brokerage affiliate agreements;
3. Compensation of registered and unregistered persons;
4. Customer disclosure and written acknowledgement;
5. Use of confidential financial information; and
6. Communications with the public.
The introduction to subsection (c) provides that no member shall
conduct broker/dealer services on the premises of a financial
institution 4 unless the member complies initially and
continuously with the requirements of the proposed rule.
\4\ The term ``financial institution'' is defined in proposed
subsection (b)(1) as federal and state chartered banks, savings and
loans, savings banks, credit unions and the service corporations
required by law of such institutions.
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Setting. Subsection (c)(1) states that, wherever possible, broker/
dealer services 5 shall be conducted in an area physically
distinct from the retail deposit taking area of the financial
institution. In all situations, the broker/dealer services must be
identified in a manner that clearly distinguishes them from the
activities of the financial institution. Finally, a member must clearly
display its name in the area where broker/dealer services are provided.
\5\ The term ``broker/dealer services'' is defined in proposed
subsection (b)(4) as meaning investment banking or securities
business as defined in paragraph (l) of Article I of the By-Laws.
Paragraph (l) of Article I reads:
(l) ``investment banking or securities business'' means the
business, carried on by a broker, dealer, or municipal securities
dealer (other than a bank or department or division of a bank), or
government securities broker or dealer of underwriting or
distributing issues of securities, or of purchasing securities and
offering the same for sale as a dealer, or of purchasing and selling
securities upon the order and for the account of others.
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The NASD recognizes that physical limitations in the space occupied
by some financial institutions may prevent ideal physical distinctions
of broker/dealer activities from the retail deposit-taking area of the
financial institution from being maintained. Accordingly, the NASD has
qualified the physical distinction requirement in this provision by the
phrase ``wherever possible.''
In addition, the provision requires members to identify and clearly
distinguish their activities from those of the financial institution,
and to clearly display the member's name in the area where broker/
dealer services are provided. The NASD expects that the three
requirements in this provision, working in combination, will achieve
the desired result, that is, the elimination of confusion among
customers of the financial institution over which entity they are doing
business with. The NASD expects that members unable to achieve ideal
physical distinction of their broker/dealer activities from the
financial institution's retail deposit taking area will pay particular
attention to the other provisions of subsection (c)(1) in order to
eliminate customer confusion and misidentification.
Finally, the NASD is aware of circumstances where financial
institutions conduct business from walkup windows, kiosks or desks in
public places, such as supermarkets or similar locations, many of which
are operated by a single person. While the NASD cannot anticipate how
the proposed rule would apply in all possible scenarios, the NASD
believes it may be particularly difficult to adequately distinguish
between the activities of the financial institution and the member as
required by subsection (c)(1) in a setting such as a walkup window,
kiosk or desk operated by a single person. Some of the difficulties
with such settings could be resolved if the member exercises
exceptional caution and adopts specific operational controls designed
to avoid customer confusion and adequately distinguish its operations
from those of the financial institution. However, the NASD expects
members to be aware that there may be certain business settings of
financial institutions where the member will not be able to comply with
the requirements of subsection (c)(1), and may, therefore, be prevented
from conducting business in such a location.
Networking and Brokerage Affiliate Agreements. Subsection (c)(2) of
the proposed rules specifies that networking 6 and brokerage
affiliate 7
[[Page 11917]]
arrangements between a member and a financial institution must be
governed by a written agreement that sets forth the responsibilities of
the parties and the compensation arrangements, including: (1) Access by
broker/dealer supervisory and regulatory persons to the financial
institution's premises to inspect the member's books and records; (2) a
prohibition on transaction-related cash or non-cash compensation to
unregistered employees of the financial institution for referrals of
financial institution customers to the member; and, (3) the member's
obligations to notify the financial institution if any associated
person of the member is terminated for cause. The proposed rule
explicitly contemplates that members will not be able to conduct a
securities business on the premises of a financial institution unless a
written agreement that complies with subsection (c)(2) is in place.
\6\ The terms ``networking arrangement'' and ``brokerage
affiliate arrangement'' are defined in proposed subsection (b)(2) as
a contractual arrangement between a member and a financial
institution permitting the member to provide brokerage services on
the premises of the financial institution.
\7\ The term ``affiliate'' is defined in proposed subsection
(b)(3) as a company which controls, is controlled by or is under
common control with a member as defined in Schedule E of the NASD
By-Laws. The formulation of this definition is consistent with
definitions elsewhere in the securities laws, principally Section 20
of the 1934 Act. The NASD is also making express reference to the
more detailed definition of affiliate in Schedule E, Section 2(a),
in order to provide additional guidance to members about what
constitutes an affiliate.
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The requirement that the agreement provide for access by the
member's supervisory and NASD and SEC regulatory personnel to the
financial institution's premises is intended to ensure that the
existing right of such persons and entities to examine the books and
records of the member, are not affected by the fact that the member is
located on the premises of a financial institution.
Compensation of Registered/Unregistered Persons. Proposed
subsection (c)(3) prohibits members from providing cash or non-cash
compensation to employees of the financial institution who are not
registered with an NASD member. Activities for which members may not
compensate unregistered persons include, but are not limited to, those
activities which, under the 1934 Act, may only be conducted by a
registered broker/dealer or a person associated with a registered
broker/dealer: the activities include, but are not limited to,
locating, introducing, or referring customers of the financial
institution to the member.
Customer Disclosure and Written Acknowledgment. Proposed subsection
(c)(4) specifies the disclosures that a member must make to a customer
when the customer opens an account with the member on the premises of a
financial institution. Members must disclose, orally and in writing,
that securities products sold in a transaction with the member: (1) Are
not insured by the Federal Deposit Insurance Corporation (``FDIC'') or
other applicable deposit insurance; (2) are not deposits or obligations
of, nor are they guaranteed by, the financial institution; and (3) are
subject to investment risks, including loss of principal invested. The
proposed disclosures are consistent with the disclosure provisions in
the Interagency Statement.
The NASD is proposing these disclosure provisions to address and
eliminate customer assumptions and confusion that the securities they
are purchasing from broker/dealers operating on the premises of
financial institutions are either insured or guaranteed against loss of
principal. Such beliefs apparently arise because customers mistakenly
assume that the same insurance and guarantees that cover the deposit-
type products of the financial institution also cover the securities
products of the broker/dealer.
Subsection (c)(4) also requires members to make reasonable efforts
to obtain a written acknowledgement of the required disclosures during
the account opening process. This provision is intended to complement
the oral and written disclosures members are required to give to
customers opening new accounts on the premises of a financial
institution. At the time the account is opened the member will provide
the disclosures, both orally and in writing, and then seek to have the
customer acknowledge the disclosures in writing. Because some customers
may be reluctant to provide the written acknowledgement at the time the
account is opened (or, indeed, at any time), the NASD is not mandating
that the acknowledgement be obtained, just that the member make
reasonable efforts to obtain it.8
\8\ The approach taken by the NASD in this provision is
consistent with the approach adopted by the NASD in connection with
obtaining suitability information under Article III, Sections 2(b)
and 21 of the Rules of Fair Practice.
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Use of Confidential Financial Information. Proposed subsection
(c)(5) prohibits members conducting business on the premises of a
financial institution from using confidential financial information
provided by the financial institution unless prior written approval has
been granted by the financial institution customer to release the
information. Proposed subsection (b)(5) defines ``confidential
financial information'' 9 in terms of what it is not: i.e., it is
not lists of customer names, addresses and telephone numbers, unless
the customer has specified otherwise; and it is not information that
could be obtained from unaffiliated credit bureaus 10 or similar
companies in the ordinary course of business. Therefore, information
concerning a customer that a member obtains from a financial
institution with which it has a networking or brokerage affiliate
arrangement (other than the name, address, and telephone numbers of the
customer, or that the member could obtain on its own from an
unaffiliated credit bureau) may not be used unless the customer has
granted prior written approval to the financial institution to release
the information. Moreover, a member must satisfy itself that the
customer has granted permission to release the information, either by
obtaining copies of the written release from the financial institution,
or by obtaining approval directly from the customer to release the
information, before the member is permitted to use such information. In
accordance with the intent of this provision, a member may not, for
example, use a customer list sorted by the financial institution
according to a field of information that would be confidential if
released as individual customer information; e.g., lists of customers
with expiring Certificates of Deposits or net worth in excess of
$100,000.
\9\ The NASD states that the definition of ``confidential
information'' is based on the language of HR 1062 pending in the
U.S. House of Representatives and the ``credit bureau'' exception is
intended to except from the provision information regarding a
customer that the member can obtain in the ordinary course of its
business.
\10\ NASD staff believes that standard information maintained by
a credit bureau relates to credit history events, such as liens,
loans outstanding, lines of credit, and credit cards, as opposed to
net worth information that would include the value of customer
assets, such as property, depository accounts, certificates of
deposit, securities, and other investments.
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Communications With the Public. Proposed subsection (c)(6) sets
forth requirements for all communications with customers of members
operating on the premises of a financial institution, including,
account statements, confirmations, advertisements and sales literature.
Paragraph (c)(6)(A) requires that all communications regarding the
securities transactions of customers of members doing business on the
premises of a financial institution clearly indicate that the broker/
dealer services are provided by the member. Moreover, communications
that include information about non-deposit-insured transactions and
positions with the member and deposit-insured transactions and
positions or accounts with the financial institution should be clearly
distinguished from each other. The NASD also notes that if members
issue account statements jointly with a financial institution, the
member must
[[Page 11918]]
ensure that the account statement complies with Article III, Section 45
of the Rules of Fair Practice, which requires members to periodically
send account statements to their customers, as well as with the
proposed new provision.
Finally, communications about securities transactions conducted by
the member should be introduced to the customer in such communications
with the identity of the member, and disclose to the customer that
securities products are not insured by the FDIC or other applicable
deposit insurance, are not deposits or obligations of the financial
institution, are not guaranteed by the financial institution, and are
subject to investment risks, including possible loss of principal
invested. This provision is intended to provide the same disclosures in
all communications with the customer as are provided when the account
is opened.
Proposed paragraph (c)(6)(B) provides that advertisements, sales
literature and other similar materials issued by the member which
relate exclusively to its broker/dealer services will be deemed the
materials of the member and must indicate prominently the identity of
the member providing the services. The material may include non-
prominent references to the financial institution where the broker/
dealer is conducting business in order to identify the location where
broker/dealer services are available. In addition, such a non-prominent
reference to the financial institution may be included to disclose a
material relationship between the member and financial institution,
such as that of an investment adviser to an investment company.
Proposed paragraph (c)(6)(C) provides that advertisements, sales
literature and other similar materials jointly issued by the member and
a financial institution that discuss services or products offered by
both entities must clearly distinguish the products and services
offered by the broker/dealer from those offered by the financial
institution. The member's name must appear prominently in the portion
of the materials that describes the broker/dealer services and products
offered by the member. That section of the materials will be deemed to
be the materials of the member. In addition, the NASD intends to review
the entire contents of all joint advertisements, sales literature and
similar material to determine if the context within which the member's
material appears complies with the NASD's advertising rules. For
example, if a member's joint advertising material with a financial
institution, when read in the context of the joint advertisement, fails
to comply with the NASD's rules, the NASD may ask the member to seek
modification of any part of the joint advertisement or require that the
member not participate in the joint advertisement. In the event the
member is unable to or chooses not to modify the joint advertisement,
the member may, nevertheless, publish its portion of the advertisement
separately (provided the advertisement complies with the NASD's rules).
The intent of subsection (c)(6) in general, and of paragraphs
(c)(6)(B) and (c)(6)(C) in particular, is to prevent investor confusion
between the products and services offered by the broker/dealer and the
products and services offered by the financial institution, as well as
to establish that advertising and sales literature promoting the
products and services of the member conducting business on the premises
of a financial institution are subject to the regulatory oversight of
the NASD. With respect to such materials, the member must comply with
all provisions of the NASD's rules including, but not limited to, the
NASD's advertising rules, Article III, Section 35 of the Rules of Fair
Practice.
Effective Date
The NASD will announce the effective date of the proposed rule
change in a Notice to Members to be published no later than 60 days
following Commission approval. The effective date will be no more than
60 days following the publication of the Notice to Members announcing
Commission approval.
The NASD believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(6) of the Act 11 in that
regulating the conduct of broker/dealers on the premises of financial
institutions will alleviate customer confusion in dealing with such
entities and provide a regulatory framework for regulating such broker/
dealer activities with the result that investors will be able to make
more informed investment decisions with a better understanding of the
distinctions between the securities industry and other segments of the
financial services industry, in furtherance of the requirement that the
Association's rules promote just and equitable principles of trade,
prevent fraudulent and manipulative acts and practices, and protect
investors and the public interest.
\11\ 15 U.S.C. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition
In response to NASD Notice to Members 94-94, a number of
commentators 12 noted that the proposed rule language in that
Notice required members to disclose to customers that securities
products purchased or sold by the member are not insured by the
Securities Investor Protection Corporation (``SIPC'').13 The
commentators noted that because such disclosures would apply only to
broker/dealers operating on the premises of a financial institution, it
would unnecessarily discriminate among broker/dealers when customers of
all broker/dealers are subject to the same potential confusion about
the nature of SIPC insurance.14 The commentators argued that if
there was going to be such a requirement at all, the disclosures should
apply to all member firms whether they operate on the premises of a
financial institution or not. Moreover, the commentators argued that
limiting SIPC disclosure to financial institution broker/dealers is not
only anti-competitive but misleading because customers who are already
susceptible to confusion about the nature of SIPC insurance would have
their attention drawn to SIPC without a requirement that SIPC insurance
be explained to eliminate customer misperceptions.
\12\ Copies of comment letters received by the NASD on this
previous proposal are available for inspection and copying at the
NASD and in the Commission's Public Reference Room.
\13\ See, Notice to Members 94-94 (December 1994), proposed
subsection (c)(9)(D).
\14\ See, comment letters 1, 3, 4, 7, 8, 17, 18, 22, 23, 25, 27,
37, 40, 47, 48, 50, 52, 54, 56, 63, 64, 77, 81, 84, 88, 92, 94, 99,
100, 104, 107, 109, 110, 115, 119, 121, 122, 123, 129, 130, 140,
142, 147, 153, 155, 167, 168, 169, 174, 177, 184, 186, 189, 190,
193, 197, 204, 207, 208, 212, 216, 225, 226, 227, 230, 236, 239,
240, 242, 256, 258, 266, 269, 270, 271 and 279.
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In response to the commentators, the NASD has determined to
eliminate the SIPC disclosure requirement from the proposed rule
change, and rely instead on the disclosures that remain in the proposed
rule change which are consistent with provisions contained in the
Interagency Statement issued by the four bank regulators. The
provisions that remain in the proposed rule change require members to
disclose to customers that securities products sold by the member (1)
Are not deposit insured, (2) are not deposits of or other obligations
of the financial institution and are not guaranteed by the financial
institution, and (3) are subject to investment risks, including
possible loss of principal invested.
Some commentators have argued that the other disclosure
requirements that were contained in the proposed rules that were
published in Notice to Members 94-94 (that remain in the proposed rule
change) are
[[Page 11919]]
discriminatory and burdensome on the class of broker/dealers that
conduct broker/dealer activities on the premises of a financial
institution. The NASD believes that the provisions of the proposed rule
change as revised are necessary to address a specific problem (customer
confusion) that the NASD has identified in connection with the
activities of members conducted on the premises of a financial
institution and has, in general, narrowly tailored the proposed rule
change to address the problem.
Therefore, the NASD does not believe that these provisions or any
other provisions of the proposed rule change will result in any burden
on competition that is not necessary or appropriate in furtherance of
the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
The proposed rule change was published for comment in Notice to
Members 94-94 (December 1994) (hereinafter referred to as ``original
proposed rule change'' or ``original proposed rules''). 284 comments
were received in response thereto. Of the 284 comment letters received,
54 were in favor of the proposed rule change, 51 of which requested
modifications, 209 were opposed, and 21 were neither in favor nor
opposed.
I. General Comments
A. Jurisdiction of the NASD in the Proposed Rules. Several
commentators, including the American Bankers Association (``ABA''), the
Bank Securities Association (``BSA''), and the Consumer Bankers
Association (``CBA''), expressed their belief that certain provisions
of the original proposed rules would subject the activities of banks to
NASD regulation.15 The commentators stated that by subjecting
banks to regulation as broker/dealers, the proposed rules fail to
recognize the exemption from broker/dealer registration that is
afforded to banks under Section 3(a)(6) of the 1934 Act. The
commentators maintained that the proposed rules also ignore the well-
settled authority of banks to provide securities brokerage services
directly to their customers under the Glass-Steagall Act, and cited
American Bankers Association v. Securities and Exchange Commission, 804
F.2d 739 (D.C. Cir. 1986) in support.
\15\ See, comment letters 1, 5, 7, 8, 17, 19, 21, 22, 23, 27,
28, 30, 37, 40, 48, 51, 54, 56, 62, 63, 65, 67, 77, 80, 84, 90, 92,
99, 102, 107, 108, 111, 115, 118, 122, 123, 126, 127, 129, 131, 138,
141, 147, 148, 156, 158, 173, 179, 186, 188, 189, 190, 192, 195,
204, 207, 208, 209, 212, 214, 216, 225, 226, 227, 229, 233, 234,
236, 242, 266, 269, 270 and 271.
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In considering the NASD's jurisdictional reach, the ABA, BSA, CBA,
and several other commentators also argued that the NASD has
incorrectly interpreted the Securities and Exchange Commission's no-
action letter to Chubb Securities Corporation (the ``Chubb Letter'').
Because the Chubb Letter was intended to govern thrift institutions
that are not exempt from broker/dealer registration under the 1934 Act,
the commentators stated that it is inappropriate to extend the
requirements of the Chubb Letter to banks which are otherwise exempt
from broker/dealer registration by means of the device of the proposed
rule change.16 Because the Chubb Letter is neither legislation nor
regulation, the commentators stated that it does not give the NASD the
authority to disregard the bank exemption in the 1934 Act in order to
regulate banks.
\16\ See, comment letters 1, 8, 17, 19, 27, 80, 84, 89, 103,
115, 122, 123, 134, 138, 180, 209, 210 and 242.
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The NASD never intended to, and the proposed rule change does not,
extend its jurisdictional reach to banks and other financial
institutions that are not members of the Association, nor to their
employees. Accordingly, the NASD has amended subsection (a) to clarify
that the proposed rule change applies only to NASD members providing
broker/dealer services on the premises of a financial institution.
Comments about the jurisdictional reach of specific provisions of
the original proposed rules are addressed in more detail below.
B. Regulatory Duplication. Several commentators said that the
proposed rule change duplicates existing regulations. One group of
commentators argued that the Interagency Statement issued by the
financial institution regulators on February 15, 1994, and other
existing financial institution regulations adequately address the
activity governed by the proposed rule change.17 In general, these
commentators maintained that the activity addressed by the original
proposed rules should be governed by financial institution regulations,
as opposed to rules promulgated by the SEC or the NASD. In addition,
another group of commentators, which included the ABA, BSA, and CBA,
argued that some of the provisions of the original proposed rules were
redundant of existing NASD, SEC and financial institution regulations.
With respect to NASD rules, the commentators referenced existing branch
office registration requirements, supervisory requirements, and
personnel registration/associated persons provisions of the NASD rules.
While these commentators recognized that additional regulation of
financial institution broker/dealer 18 activities are appropriate,
they argued that additional regulations are already in place in the
form of the Interagency Statement and financial institution
regulations, the Chubb Letter and existing NASD rules. The commentators
believed that these guidelines, interpretations and rules adequately
address the activities that would be governed by the proposed
rules.19
\17\ See, comment letters 1, 5, 8, 18, 21, 22, 31, 37, 38, 40,
47, 53, 54, 56, 58, 62, 65, 70, 75, 78, 91, 94, 99, 100, 101, 107,
108, 111, 126, 127, 130, 133, 138, 141, 145, 147, 151, 158, 169,
170, 179, 184, 186, 188, 190, 196, 211, 216, 218, 220, 225, 226,
227, 229, 230, 232, 236, 238, 241, 242, 245, 255, 266, 268, 269,
270, 271, 275 and 282.
\18\ As used in this rule filing, the term ``financial
institution broker/dealer'' refers to broker/dealers affiliated with
financial institutions (as defined in the proposed rule the term
``financial institution'' means ``federal and state-chartered banks,
savings and loan associations, savings banks, credit unions, and the
service corporations required by law of such institutions'') or
conducting business with financial institutions under networking
arrangements. The term ``non-financial institution broker/dealer''
refers to broker/dealers not affiliated with, or conducting business
under a networking arrangement with, financial institutions.
\19\ See, comment letters 2, 7, 9, 10, 11, 17, 19, 23, 24, 25,
27, 28, 29, 30, 32, 33, 34, 35, 36, 37, 41, 42, 43, 44, 45, 48, 49,
52, 53, 55, 59, 60, 61, 63, 64, 66, 67, 68, 69, 71, 74, 76, 77, 82,
84, 87, 90, 92, 97, 102, 105, 114, 115, 116, 117, 118, 119, 120,
121, 122, 124, 128, 129, 131, 132, 148, 149, 153, 156, 157, 160,
161, 162, 163, 165, 166, 168, 169, 172, 173, 174, 175, 177, 178,
184, 189, 194, 195, 197, 201, 204, 207, 208, 209, 224, 225, 228,
231, 235, 242, 243, 246, 247, 248, 249, 250, 257, 258, 259, 261,
262, 263, 273, 279, 280, 281 and 283.
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The NASD agrees that some of the provisions of the original
proposed rules duplicated existing NASD rules. Accordingly, the NASD
has amended the proposed rules to eliminate such duplication as
described in more detail below. With respect to arguments that the
proposed rules duplicate the rules of other regulatory entities (e.g.,
the Interagency Statement), the NASD notes that many of the rules,
policies and guidelines of other agencies do not directly or indirectly
apply to NASD members. The NASD believes it is imperative to adopt a
set of rules that establishes clear standards of conduct governing the
practices of member firms operating on the premises of financial
institutions that are enforceable by the NASD.
C. Discriminatory Impact and Anti-Competitive Effects. The ABA,
BSA, CBA and many other commentators believe that it is inappropriate
to establish separate regulations to govern
[[Page 11920]]
broker/dealers operating on financial institution premises than those
in existence for other NASD members.20 In general, these
commentators believe that the proposed rules unfairly discriminate
against a class of broker/dealers in violation of Section 15A(b)(6) of
the 1934 Act. The commentators argued that the 1934 Act provides no
basis for a classification of broker/dealers based on location.
\20\ See, comment letters 1, 2, 5, 7, 8, 9, 11, 17, 19, 21, 23,
24, 25, 27, 29, 30, 31, 32, 33, 34, 35, 36, 43, 48, 49, 52, 54, 55,
56, 59, 61, 63, 64, 66, 67, 68, 69, 71, 74, 76, 77, 82, 84, 86, 87,
88, 89, 91, 92, 97, 98, 102, 104, 105, 107, 108, 115, 116, 118, 119,
121, 122, 123, 124, 125, 126, 127, 128, 129, 131, 132, 139, 141,
142, 147, 149, 157, 159, 162, 163, 164, 165, 168, 173, 175, 178,
179, 184, 189, 194, 195, 197, 204, 208, 209, 213, 219, 218, 220,
225, 226, 227, 228, 229, 230, 236, 235, 240, 243, 242, 244, 249,
250, 257, 258, 259, 261, 262, 263, 264, 265, 273, 276, 279, 280, 281
and 283.
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The NASD has identified circumstances associated with conducting
broker/dealer services on the premises of a financial institution that
are unique to that location and that require rules which specifically
address the conduct of members engaging in such business. The principal
circumstance noted is the enhanced likelihood that customers of the
financial institution may not be aware of the differences between the
insured depository products of the financial institution and the
uninsured securities products of the broker/dealer operating in the
same location. Accordingly, the NASD has determined that it is in the
public interest to propose rules to address these unique circumstances.
The NASD believes, therefore, that it is acting in furtherance of the
1934 Act in proposing rules to regulate the activities of broker/
dealers on the premises of financial institutions in order to address
on-going problems of customer confusion and the adequacy of the
disclosures made.
These commentators also asserted their view that the NASD has not
provided statistical data to support its contention that financial
institution broker/dealers should be subject to a ``higher standard of
regulation.'' These commentators believe that the proposed rules are
anti-competitive because, in their view, they create an uneven
regulatory scheme favoring non-financial institution broker/dealers
over financial institution broker/dealers. The NASD does not believe
that the proposed rule change is anti-competitive in that the revised
rule filed herein is, in general, narrowly structured to address its
concern of customer confusion and investor protection.
In addition, two commentators speculated that the proposed rules
are a reflection of the NASD's on-going battle with the financial
institution regulators.21 One commentator expressed its belief
that the proposed rules are a reflection of competitive pressures from
NASD members who fear financial institution incursions into the
securities industry.22 Finally, one commentator expressed the
opinion that the rules are punitive of members who are seeking to do
business with financial institutions.23
\21\ See, comment letters 127 and 258.
\22\ See, comment letter 235.
\23\ See, comment letter 66.
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The NASD regrets that any commentators believe that there is a non-
regulatory motivation to the proposed rules, but there is no basis for
such comments. The NASD has responded to commentators by modifying the
rules to clarify their jurisdictional reach, provide for greater
flexibility of compliance in certain cases, and narrow the provisions
to those most clearly applicable to addressing the potential for
customer confusion in connection with the conduct of broker/dealer
services on the premises of a financial institution.
D. Conflicting Banking and NASD Regulations. The ICI, the OCC, the
FRB, the ABA, BSA, CBA, and other commentators expressed concern about
requiring financial institution broker/dealers to comply with
potentially conflicting requirements of the NASD and financial
institution regulators.24 The ICI stated that in the absence of
functional regulation of securities activities of various entities, the
financial institution broker/dealer regulations of the various
regulators must be coordinated and harmonized in order to reduce
burdens on industry participants. These commentators cited
inconsistencies between the proposed rule change and the Interagency
Statement as an example. To the extent that the proposed rule change
differs from the Interagency Statement, these commentators asserted
that member firm compliance will be both challenging and expensive. In
addition, a few commentators requested that the proposed rule change be
amended to provide a regulatory conflict resolution process.25
\24\ See, comment letters 1, 3, 4, 6, 7, 8, 9, 10, 11, 12, 16,
17, 23, 25, 27, 28, 30, 32, 47, 48, 63, 64, 65, 81, 82, 83, 84, 89,
92, 99, 100, 101, 102, 103, 104, 107, 108, 109, 110, 113, 115, 119,
120, 123, 129, 133, 135, 145, 147, 151, 153, 154, 156, 163, 166,
167, 172, 173, 180, 182, 183, 184, 188, 190, 191, 192, 196, 208,
209, 210, 211, 212, 213, 215, 216, 224, 230, 234, 237, 239, 252,
266, 236, 269, 270, 271, 272, 275, 279 and 282.
\25\ See, comment letters 135, 146, 156 and 239.
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To resolve these concerns, the NASD has amended the original
proposed rules to eliminate, to the degree possible, inconsistencies
and conflicts between the proposed rules and existing rules and
guidelines of financial institution regulators, as discussed in more
detail below. Unless regulatory conflicts arise, which the NASD is not
currently aware of, it is unnecessary to institute a conflict
resolution process. The NASD agrees that the regulations of various
regulators must be consistent and intends to continue communications
with the financial institution regulators in order to coordinate
interpretations and application of common provisions to avoid such
problems before they develop.
E. Rationale for the New Rules. Some commentators questioned the
rationale for the proposed rule change: The need to address issues of
investor confusion and to provide clear guidance through rules or
regulations addressing the activities of financial institution-
affiliated and networking broker/dealers operating on the premises of
financial institutions.26
\26\ See, comment letters 53, 66, 67, 115, 127, 150, 185, 190,
214, 235 and 258.
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As discussed above, the NASD has business practice and investor
protection concerns that it believes justify the adoption of the
proposed rules. The NASD believes the proposed rule change is a
measured response to the concerns that have been identified and the
unique circumstances present with respect to broker/dealers operating
on the premises of a financial institution.
F. Disparate Treatment of Investors. Some commentators argued that
financial institution customers should not be treated as a separate
class of investors for purposes of customer protection.27 These
commentators said that such disparate treatment suggests that financial
institution customers are less sophisticated than those who deal with
separate, full service, broker/dealers.
\27\ See, comment letters 10, 53, 78, 102, 115, 136, 204, 207
and 258.
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The NASD disagrees that the proposed rule change suggests that
financial institution customers are less sophisticated than customers
of full service broker/dealers. As discussed above, the NASD has
identified circumstances associated with conducting broker/dealer
services on the premises of a financial institution that appear to be
unique to that location. The principal circumstance noted is the
enhanced likelihood that customers of
[[Page 11921]]
the financial institution may not be aware of the differences between
the insured depository products of the financial institution and the
uninsured securities products of the broker/dealer operating in the
same location. Accordingly, the NASD has determined that it is the
public interest to propose rules to address these unique circumstances.
II. Specific Comments
A. Applicability. Subsection (a) of the original proposed rules
provided that the section would apply exclusively to the activities of
members that conduct broker/dealer services on the premises of a
financial institution where retail deposits are taken.
The ICI, BSA, CBA, and a number of other commentators asked that
the NASD amend subsection (a) of the proposed rules to clarify that the
rules apply only to financial institution sales activities that could
confuse retail customers about the uninsured nature of the securities
products that are being offered.28 The commentators noted that the
Interagency Statement only applies to retail sales of non-deposit
investment products. The NASD believes that the proposed rules are
generally consistent with the Interagency Statement in that they apply
to all non-deposit investment products sold by a member that is
conducting business on the premises of a retail deposit-taking
institution.
\28\ See, comment letters 11, 27, 29, 75, 84, 94, 121, 159, 167,
172, 186, 208, 210, 211 and 274.
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The ICI, BSA, CBA, and several other commentators also requested
that the NASD clarify the phrase ``on the premises'' in subsection (a)
to enable members to determine the applicability of the rules under
various scenarios, such as, where a member is located within a
financial institution building but on a separate floor.29
Commentators also asked whether the proposed rules apply where a member
leases space in a building owned by a financial institution, but the
member is not in a networking arrangement with the financial
institution nor is the member a financial institution affiliate.
\29\ See, comment letters 17, 21, 27, 29, 52, 63, 84, 106, 110,
115, 121, 129, 148, 167, 172, 177, 186, 192, 207, 208, 242, 245 and
260.
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Subsection (a) has been clarified to specify that the provisions
apply only to ``those broker/dealer services being conducted by NASD
members on the premises of a financial institution where retail
deposits are taken.'' It is intended that, generally, broker/dealer
services will be considered separate from the retail deposit taking
area of a financial institution if the broker/dealer's facilities can
be entered without going through the retail facility of the financial
institution. Thus, the proposed rules would not apply where the member
and the financial institution are located in physically separate and
separately identified offices.
Finally, the BSA recommended that subsection (a) be amended to
include within the coverage of the proposed rule non-financial
institution broker/dealers that offer deposit-insured financial
institution products directly. The BSA expressed the opinion that such
an amendment was warranted because the investor protection concerns
addressed by the proposed rule change are equally as relevant with
respect to non-financial institution broker/dealers that sell financial
institution products.
The NASD does not agree and has no evidence that similar investor
protection concerns are present with respect to customers of non-
financial institution broker/dealers that sell financial institution
products. The NASD believes that if such broker/dealer customers are
confused about the nature and risks of securities products they are
likely to believe that none of the products they purchase are insured
when, in fact, the customer may acquire an insured product. Thus, any
customer confusion would appear to have benign results. The NASD will,
however, continue to monitor this area.
B. Definitions. Subsection (b) of the original proposed rules
included definitions of the terms ``financial institution,''
``networking arrangement,'' ``brokerage affiliate of a financial
institution,'' ``dual employees,'' and ``broker/dealer services.'' The
definitions of ``financial institution'' and ``broker/dealer services''
are retained in the revised rule and discussed below. The definitions
of ``networking arrangement'' (which has been amended to add
``brokerage affiliate arrangement'') and ``brokerage affiliate of a
financial institution'' (which has been amended to, simply,
``affiliate'') did not generate any comments and are, therefore,
discussed later in connection with the provisions where the terms
appear. The term ``dual employees'' was deleted from the proposed rule
change in connection with the NASD's revision of the original proposed
rules, but not in response to a particular comment. Therefore, it is
not discussed here. Finally, a definition of the term ``confidential
financial information'' was added to subsection (b). That term is
discussed below in connection with the provision where it occurs.
1. ``Financial Institution.'' The BSA, CBA, the FRB, and First
Fidelity expressed the concern that the definition of the term
``financial institution'' set forth in paragraph (b)(1) of the original
proposed rule change inappropriately combines financial institutions
and non-financial institution entities such as savings associations and
credit unions within the same defined term.30 These commentators
also expressed their view that it is inappropriate to include service
corporations within the definition of financial institution because
service corporations themselves may be registered as broker/dealers.
The NASD notes that the language of this definition is drawn from the
Chubb Letter and is necessary for the proper operation and application
of the proposed rule. The NASD has, however, amended the definition to
ensure that it applies only to the proposed rule and not to any other
NASD rule.
\30\ See, comment letters 27, 84, 103 and 199.
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The FRB also suggested that the NASD consider expanding the
definition of financial institution to include foreign financial
institutions given that a number of foreign financial institutions have
established branches in the United States, and several of these
institutions have broker/dealer affiliates. The NASD believes that it
is not appropriate to include within the scope of the rule foreign
financial institutions not required to register as a bank, savings and
loan or credit union.
2. ``Broker/dealer Services.'' The ABA, BSA, CBA , and several
commentators expressed concerns about the scope of the term ``broker/
dealer services'' as defined in paragraph (b)(4) of the original
proposed rule change.31 The commentators stated that the proposed
definition improperly limits the activities of unregistered financial
institution employees. Accordingly, the commentators have recommended
that the definition be amended to state that nothing in the proposed
rules is intended to limit the ability of financial institutions and
their employees to engage in securities transactions pursuant to the
exemption from broker/dealer registration that is granted to banks by
Section 3(a)(6) of the 1934 Act.
\31\ See, comment letters 4, 8, 17, 19, 21, 25, 27, 28, 29, 54,
62, 63, 80, 84, 106, 115, 121, 131, 129, 192, 173, 186, 207, 208,
242, 267, 260, and 281.
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Further, the ABA and BSA raised the concern that it was unclear
whether or not the proposed rule is intended to reach investment
banking services offered by bank trust departments where services are
offered by individuals who hold NASD licenses. Because the term
``investment banking and securities business'' has a settled meaning
within the broker/dealer industry, the BSA
[[Page 11922]]
recommends that the NASD adopt the ``investment banking'' definition in
paragraph (h) of Article I of the NASD By-Laws to address the problems
raised with regard to the proposed broker/dealer services definition.
In this regard, it was never the intent of the NASD to extend its
jurisdictional reach to banks and other financial institutions. In
response to these comments, the NASD sought to clarify its intent by
amending the definition of ``broker/dealer services,'' to reference the
definition of ``investment banking and securities business'' contained
in Article I, Paragraph (l) of the NASD By-Laws. The definition in
Article I of the By-Laws excludes investment banking and securities
activities carried on by banks, including bank trust departments. In
addition, as discussed above, the NASD has amended subsection (a) to
clarify that the proposed rule change applies only to broker/dealer
services conducted on the premises of a retail-deposit-taking financial
institution. The NASD believes that these changes clarify that the
proposed rule change does not seek to regulate the securities
activities of banks that are exempt from broker/dealer registration.
C. Specific Provisions Relating to Activities of Members Operating
on the Premises of a Financial Institution. 1. Physical Location.
Subsection (c)(1) of the original proposed rules provided that a
member's broker/dealer services shall be conducted in a physical
location distinct from the area where the financial institution's
retail deposits are taken. Several commentators requested clarification
about the definition of ``where retail deposits are taken'' in
subsection (c)(i) and to the term ``deposit-taking area'' 32 used
in other provisions (i.e., is it the teller area of a financial
institution?)
\32\ See, comment letters 6, 8, 12, 16, 17, 27, 29, 30, 52, 58,
63, 64, 77, 80, 83, 86, 110, 129, 153, 155, 167, 177, 186, 193, 207,
208, 213, 239, 244, 260 and 282.
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Many commentators criticized subsection (c)(i) as not providing
adequate flexibility for financial institution locations with severe
physical constraints.33 These commentators asked the NASD to
address the problem by adopting the Interagency Statement standard
which, in relevant part states, ``in the limited situation where
physical considerations prevent sales of non-deposit products from
being conducted in a distinct area, the institution has a heightened
responsibility to ensure appropriate measures are in place to minimize
customer confusion.'' 34
\33\ See, comment letters 1, 4, 8, 11, 16, 17, 19, 21, 25, 26,
27, 29, 30, 31, 47, 54, 76, 84, 88, 90, 94, 103, 107, 112, 118, 119,
121, 123, 127, 129, 130, 131, 140, 153, 154, 156, 166, 167, 176,
181, 182, 184, 189, 192, 193, 196, 204, 208, 210, 212, 215, 230,
233, 234, 237, 242, 244, 255, 267, 276, 279 and 282.
\34\ See, comment letters 27, 40, 86, 96, 181, 208, 239, 245,
256 and 283.
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Finally, the BSA and four other commentators asked whether dual
employees would be required to have two separate offices for conducting
activities on behalf of the financial institution and the broker/
dealer.35 These commentators maintained that customers could be
confused if a dual employee were required to lead customers back and
forth between two locations within the financial institution. To
address this potential for customer confusion, the BSA suggested that
the proposed rule change be amended to permit the use of one desk for
deposit and non-deposit activities. Indeed, the BSA expressed the view
that appropriately qualified dual employees should be permitted to
offer customers a ``menu'' of retail financial products, including
insured deposits and uninsured investment products, from the same
location.
\35\ See comment letters 27, 110, 182, 193, 207 and 233.
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In response to the commentators, subsection (c)(1) of the proposed
rule change was revised to require the member to operate in a distinct
area ``wherever possible,'' consistent with the Interagency Statement.
In addition, the proposed rule change has been amended to require that
the member ``distinguish'' its broker/dealer services from the services
of the financial institution as opposed to ``segregating'' its services
as required by the original proposed rule change.
With regard to the commentators' concerns regarding consistency in
regulation, the NASD has amended the physical location and signage
requirements and the proposed risk disclosures to ensure consistency
with the Interagency Statement's standards for these matters. (See, new
paragraphs (c)(1) and (c)(4), respectively.) These amendments are also
discussed in greater detail below.
2. Signage. Subsection (c)(2) of the original proposed rule change
stated, ``in no event shall signs regarding the broker/dealer services
appear in the deposit-taking area.'' Many commentators, including the
ABA, ICI, BSA, and CBA, asked whether the proposed rules would prohibit
signage in the teller window or the lobby areas.36 The
commentators argued that this requirement could interfere with
directional signage pointing toward the location of the broker/dealer,
ordinary brochure stands, mounted lists of affiliated companies, and
other signage relating to the general availability of products and
services of the broker/dealer. Rather than create confusion, the BSA
argued that directional signs can help avoid customer confusion by
clarifying that a deposit-taking area, such as a teller window, is not
the place to obtain securities products. These commentators asserted
that broker/dealer signage with appropriate disclosures should be
permitted to appear anywhere on the financial institution's premises.
\36\ See, comment letters 4, 8, 9, 10, 11, 17, 21, 23, 25, 27,
28, 30, 48, 59, 81, 83, 84, 104, 115, 119, 120, 121, 123, 129, 134,
140, 154, 156, 167, 170, 192, 204, 207, 208, 213, 232, 233, 236,
242, 244, 245, 276, 279 and 281.
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Other commentators expressed concerns about the potential impact of
the signage requirements in the case of small financial
institutions.37 These commentators noted that signage restrictions
are particularly difficult for small financial institutions and small
branch offices to deal with because practically all public areas could
be regarded as deposit-taking areas. Further, the commentators noted
that small branches may not reserve one desk solely for investment
services thus preventing the segregation desired by the original
proposed rules. The commentators also observed that signage
restrictions, when combined with the physical location requirements,
would prevent one-desk branch locations. Accordingly, these
commentators recommended that the proposed rules be amended to permit
signage that would facilitate dual usage of a service desk by broker/
dealer and financial institution employees.
\37\ See, comment letters 4, 12, 21, 29, 40, 47, 52, 54, 107,
113, 133, 156, 167, 181, 184, 196, 198, 210, 234, 242, 255, 256, 279
and 282.
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One commentator stated that, in its view, the proposed signage
restrictions would interfere with the financial institution's
commercial speech which is protected by the First Amendment of the U.S.
Constitution.38 This commentator also stated that this
interference with the financial institution's rights resulted in the
NASD's assertion of jurisdiction over the financial institution.
\38\ See, comment letter 30.
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The NASD disagrees and does not believe that the proposed rule
change infringes on the limited First Amendment protection on
commercial speech because the U. S. Constitution acts as a restraint on
governmental action and the First Amendment's free speech guarantee is
a limitation on Congress' ability to enact laws abridging
[[Page 11923]]
freedom of speech. The NASD's actions as a private, non-governmental,
securities industry, self-regulatory organization (actions that include
adopting rules or enforcing standards of business conduct) are not
governmental actions subject to Constitutional restraint. Nevertheless,
the NASD applies a standard of fundamental fairness in its dealings
with its members and its rules, including the rule change proposed
herein, are narrowly tailored to achieve legitimate regulatory
purposes. The NASD also notes that even if the NASD's regulatory
proposals were constrained by the Constitutional protection on
commercial speech, those protections are limited to the extent that
reasonable regulations of commercial speech are necessary to protect
the public interest and the proposed rule change is a reasonable
regulation of commercial speech.
Nevertheless, in response to the commentators, the NASD has amended
the proposed rule change to delete the separate provision relating to
signage, including the provisions prohibiting signs regarding broker/
dealer services in the financial institution's deposit-taking area. The
requirement in the deleted provision that a member clearly display its
name in the area where brokerage services are being conducted has been
consolidated with Subsection (c)(1) of the proposed rules. Thus, as
long as signage meets the other requirements of the proposed rule
change, as well as existing NASD rules requiring accurate information
that is not misleading under the circumstances in which it is used,
there are no other limitations.
3. Branch Office Registration Requirements. Subsection (c)(3) of
the original proposed rules restated an already existing NASD rule
requirement that the member must register as a branch office any of its
offices which operates on the premises of a financial institution. Most
commentators, including, among others, the ICI, ABA, BSA, and CBA,
asked that the provision be amended to exempt from branch registration
requirements locations where a broker/dealer meets a client in a
financial institution office for purposes of customer convenience, but
where the financial institution office is not permanently staffed by
the NASD member, nor is the location held out as a branch of the NASD
member.39 These commentators expressed significant concerns
regarding the cost of registering locations serviced by so-called
``circuit riders'' if the NASD does not amend the rule to provide an
exception for meetings between a member's registered representative and
financial institution customers that occur on an appointment basis at
financial institutions.
\39\ See, comment letters 3, 7, 8, 14, 15, 19, 23, 27, 28, 29,
30, 32, 37, 39, 40, 48, 54, 63, 75, 82, 84, 91, 96, 101, 104, 108,
109, 110, 115, 119, 121, 125, 127, 129, 140, 144, 145, 166, 167,
173, 177, 181, 189, 192, 204, 205, 207, 208, 213, 215, 230, 236,
239, 244, 251, 256, 264 and 267.
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In addition, the BSA expressed the opinion that, if the NASD has
determined to publish an interpretation of what is a ``branch office''
under Section 27(g)(2) of the Rules of Fair Practice, it should be done
in a uniform manner applicable to all NASD members and not as a formal
NASD rule applicable only to financial institution broker/dealers. The
ABA and the CBA also argued that there was no justification for
treating financial institution branches any differently than other
retail outlets for purposes of branch office registration.
Further, commentators observed that requiring registration of every
location at which a representative meets with a customer could limit
the ability of members to service customers where states do not permit
a registered representative to work out of more than one registered
location.40
\40\ See, comment letters 23, 108 and 236.
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Finally, the Independent Bankers Association of America (``IBAA'')
and two other commentators argued that the branch office registration
requirements would result in compliance problems with respect to the
books and records maintained at the financial institution
location.41 To address this concern, the IBAA asked that the rules
be amended to provide limited relief to allow financial institution
broker/dealers to maintain books and records at a more central
location, for example, the main office of the financial institution.
\41\ See, comment letters 101, 122 and 154.
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The NASD appreciates the concerns expressed by these commentators
and, accordingly, has amended the proposed rules to delete the branch
office registration requirements and, instead, rely on the branch
office registration requirements currently in effect under existing
NASD rules. Therefore, members doing business on the premises of a
financial institution will be expected to comply with the branch office
requirements in the NASD's rules that currently apply to all other
members.
4. Networking and Brokerage Affiliate Agreements. Subsection (c)(4)
of the original proposed rules provided that relationships between
financial institutions and members (whether network or affiliate) be
governed by an agreement that sets forth the responsibilities of the
parties.
Regulatory Access--Paragraph (c)(4)(A) provided that the written
agreement between the broker/dealer and the financial institution,
among other things, specify that the SEC and the NASD must be granted
access to the financial institution premises to inspect the books and
records of the broker/dealer and other relevant information maintained
by the member with respect to its broker/dealer services. With respect
to this requirement, the North American Securities Administrators
Association Inc. (``NASAA'') and the State of Iowa urged the NASD to
amend the provision to grant such access to state regulators. 42
The NASD formulated this provision to be consistent with the Chubb
Letter. It is believed that state regulators currently have appropriate
authority to have access to the premises of financial institutions to
inspect the books and records of broker/dealers. The BSA stated that
the SEC will use this right of access provision to indirectly regulate
any desired activity of a financial institution.43 The NASD
believes that the concerns of the BSA are more appropriately directed
to the SEC.
\42\ See, comment letters 203 and 254.
\43\ See, comment letter 27.
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Periodic Reviews--Paragraph (c)(2)(C) of the original proposed
rules required that the financial institution agree to permit the
member to conduct periodic reviews to assure that the financial
institution and its unregistered employees comply with the limits on
their activities with respect to securities transactions and non-
deposit broker/dealer services. One commentator stated that the
provision could be interpreted to require that an unaffiliated network
member be granted access to the books and records of its partner
financial institution for periodic reviews.44 This commentator
also stated that, if the financial institution and the networking
member compete in several lines of business, the requirement would have
had the net effect of discouraging a financial institution's
participation in networking arrangements in order to avoid disclosing
confidential business information.
\44\ See, comment letter 211.
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Further, with regard to a member conducting periodic reviews to
assure that the financial institution and its unregistered employees
comply with the limits on their activities, the ICI, BSA, CBA, and
several other commentators argued that it is inappropriate for an NASD
member to serve in the role of an auditor. They
[[Page 11924]]
argued that this responsibility is more appropriately handled by the
financial institution.45 The commentators also asserted that the
financial institution should be responsible for conducting its own
supervision, training, investigations, and compliance as it relates to
the activities of its own employees who are not registered with a
broker/dealer. The commentators stated that it is impractical for a
small number of broker/dealer employees to monitor the activities of
all unregistered financial institution employees.
\45\ See, comment letters 1, 4, 10, 17, 21, 23, 27, 28, 30, 37,
48, 59, 62, 63, 77, 80, 84, 104, 107, 121, 128, 134, 140, 142, 148,
153, 156, 181, 186, 207, 208, 234, 236, 242, 274, 281 and 282.
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Additionally, one commentator asked what actions a member could
take against a financial institution if it believes the financial
institution has not complied with the limits on its activities with
respect to securities transactions and non-deposit broker/dealer
services.46 Another commentator argued that the contractual
obligations of proposed Paragraph (c)(4)(C) would create broker/dealer
liability for financial institution employees over whom the broker/
dealer has no control. 47
\46\ See, comment letter 59.
\47\ See, comment letter 30.
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The ICI urged the NASD to revise the paragraph to require that
members only obtain a commitment from the financial institution such
that the financial institution agrees that it will promulgate and
implement procedures reasonably designed to ensure compliance with the
limits on the activities of unregistered financial institution
employees rendered in connection with the member's broker/dealer
services.
In response to the foregoing comments, the NASD has amended the
proposed rule change to delete paragraph (c)(4)(C).
Dual Employees--Paragraph (c)(4)(D) of the original proposed rules
provided that the written networking or brokerage affiliate agreement
must require that any dual employee who is suspended from association
with the member, or who the SEC, the NASD, or any other regulatory or
self-regulatory organization bars or suspends from association with the
member or any other broker/dealer, will be terminated or suspended,
respectively, from all securities activities conducted directly by the
financial institution. Many commentators strongly objected to the
jurisdictional reach of this provision.48 The commentators stated
that financial institutions must retain the discretion to determine
what situations justify an employee's termination or suspension.
\48\ See, comment letters 1, 4, 10, 17, 21, 23, 27, 28, 30, 37,
48, 59, 62, 63, 77, 80, 84, 104, 107, 121, 128, 134, 140, 142, 148,
153, 156, 181, 186, 207, 208, 234, 236, 242, 274, 281 and 282.
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One commentator stated that there may be a multitude of NASD, SEC
or other regulatory reasons for which an employee may be suspended. The
commentator maintained that some of these reasons may by regulation
require a financial institution to suspend or terminate the employee's
activities. However, the financial institution may not in the exercise
of its independent judgment consider certain other reasons as
justification for barring the employee from engaging in securities
activities conducted by the financial institution.49
\49\ See, comment letter 21.
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Further, one commentator stated that requiring the financial
institution to agree to terminate or suspend employees would result in
the creation of a ``black list'' of employees that could potentially
expose the financial institution to lawsuits by such black-listed
employees.50 Rather than adopting the proposed contractual
agreement of the financial institution to terminate or suspend
employees, one commentator proposed that financial institutions be
provided access to the Form U-5 for terminated employees.51
\50\ See, comment letter 128.
\51\ See, comment letter 28.
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In response to the foregoing comments, the NASD has amended the
proposed rule change to delete paragraph (c)(4)(D).
Competition--Paragraph (C)(4)(E) of the original proposed rules
required that a contractual agreement with the financial institution
provide that ``unregistered employees of the financial institution will
not receive any compensation, cash or non-cash, that is based on the
effectiveness or success of referrals * * * . `` Many commentators,
including the ABA, BSA and OCC, urged the NASD to define the terms
``success'' and ``effectiveness of referrals'' arguing that a
prohibition based on the effectiveness of sales rather than a
transactional nexus is too ambiguous.52 The commentators asked how
the provision would apply where the financial institution provides
payment for referrals that result in an appointment with a broker/
dealer rather than a transaction.
\52\ See, comment letters 7, 16, 19, 23, 27, 28, 37, 48, 59, 84,
86, 104, 107, 108, 110, 115, 129, 140, 142, 173, 181, 183, 186, 192,
236, 240, 244, 260, 274 and 282.
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The ABA also stated that a standard based on the success or
effectiveness of referrals is stricter than existing NASD and financial
institution standards that permit a referral payment where it is not
tied to the success of a sale or opening of a broker/dealer
account.53
\53\ See, comment letter 8.
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Other commentators, including the ABA and the BSA, challenged the
NASD's authority to regulate the compensation paid by a financial
institution to its employees through contractual obligations of an NASD
member.54 These commentators stated that, as a general matter,
financial institution regulations provide adequate investor protection
safeguards with regard to the financial institution's payment of
referral fees and, accordingly, NASD regulation of such payments was
not required.
\54\ See, comment letters 1, 11, 17, 19, 28, 62, 63, 64, 83, 84,
104, 115, 121, 128, 131, 138, 153, 192, 202, 208, 216, 224, 233,
251, 281 and 282.
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In response to the foregoing comments, the NASD has amended this
provision to prohibit compensation that is conditioned on whether a
referral results in a transaction, which is consistent with comparable
provisions of the Interagency Statement. See, paragraph (c)(2)(B) of
the proposed rule change.
Notification--Paragraph (c)(5) of the original proposed rules
provided that the networking or brokerage affiliate agreement must
require that the member notify the financial institution if any dual
employee who is associated with the member is terminated for cause by
the member. Three commentators asserted that the provision would lead
to civil penalties because the disclosure of the reasons for a
suspension and/or termination raises privacy issues which, absent
permission from the associated person, may subject the broker/dealer to
civil liabilities.55 One commentator suggested that should the
NASD determine to address the civil liability issues, it would be more
appropriate to require the broker/dealer to notify the financial
institution that it would no longer utilize the services of a financial
institution employee and, thereafter, direct the financial institution
to review the employee's Form U-5.56
\55\ See, comment letters 28, 40 and 177.
\56\ See, comment letters 28.
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The NASD has determined to retain this provision as paragraph
(c)(2)(C) substantially unchanged. The NASD believes the financial
institution should have this information in order for it to review and
determine its own regulatory obligations with respect to the terminated
individual.
5. Personnel Registration/Associated Person. Subsection (c)(6) of
the original proposed rule change provided that broker/dealer services
offered by the member could be provided only by
[[Page 11925]]
persons associated with the member, except that unregistered dual
employees of the member and financial institution could provide
``clerical and ministerial assistance.'' Several commentators requested
clarification of the phrase ``clerical and ministerial assistance,''
57 and observed that limiting employees activities to ``clerical
and ministerial'' duties could be viewed as ignoring the exemption from
broker/dealer registration afforded banks under Section (3)(a)(6) of
the 1934 Act. In addition, the commentators asked that subsection
(c)(6) be clarified to focus on the participation of unregistered
financial institution employees in a member's sales activities, rather
than participation of unregistered financial institution employees in a
financial institution's direct sales efforts.
\57\ See, comment letters 6, 16, 27, 64, 84, 104, 110, 119, 130,
142, 172, 192, 206, 208, 213, and 233.
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In response to the comments, the NASD has determined that
subsection (c)(6) is redundant of other provisions of the securities
laws and, therefore, is unnecessary. Bank employees may engage in
direct securities activities pursuant to the exemption from broker/
dealer registration contained in Section 3(a)(6) of the 1934 Act,
subject only to the restrictions on bank securities activities in
federal banking law. To the extent the employees of all other types of
financial institutions engage in securities activities, they must be
registered as associated persons of a registered broker/dealer.
Accordingly, the NASD has amended the proposed rule change to delete
subsection (c)(6).
6. Compensation of Registered/Unregistered Personnel.
Paragraph (c)(7)(A) of the original proposed rules provided that
transaction-related compensation of a member's registered
representatives, including dual employees, must be determined solely by
the member. In response, the BSA, CBA, and several other commentators
have advised the NASD that this requirement conflicts with existing
financial institution regulations that require the financial
institution to ensure that compensation does not influence sales of
unsuitable products.58 In addition, commentators maintained that
this provision would compromise the ability of a financial institution
to meet its overall company goals.
\58\ See, comment letters 7, 10, 11, 16, 17, 21, 22, 23, 25, 26,
27, 28, 37, 47, 48, 88, 94, 100, 107, 108, 110, 112, 121, 122, 123,
129, 134, 135, 140, 147, 153, 154, 166, 186, 188, 190, 192, 207,
233, 234, 236, 237, 239, 240, 242, 260, 266, 269, 270, 271 and 282.
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Paragraph (c)(7)(B) of the original proposed rule provided that
employees of the financial institution who are not registered with the
NASD member may not receive any compensation from the member, cash or
non-cash, in connection with, but not limited to, the referral of
customers of the financial institution to the member. Many
commentators, including the ICI, BSA, CBA, and the FRB, argued that the
provision is inappropriate and unwarranted because referral fees
provide an appropriate incentive to increase customer awareness of all
types of deposit and non-deposit products that are available to
financial institution customers.59 Moreover, commentators argued
that banning such referral payments would create a competitive
disadvantage for financial institution broker/dealers because members
who do not operate on the premises of a financial institution have more
leeway under SEC no-action letters and enforcement decisions in
providing compensation to unregistered persons.
\59\ See, comment letters 1, 3, 7, 8, 16, 18, 21, 22, 23, 25,
26, 27, 28, 29, 40, 44, 46, 59, 63, 75, 84, 88, 92, 93, 95, 98, 99,
100, 108, 111, 112, 115, 121, 123, 127, 129, 130, 135, 142, 143,
147, 153, 156, 166, 167, 168, 172, 188, 189, 191, 193, 204, 207,
210, 212, 213, 214, 230, 232, 235, 236, 239, 240, 244, 252, 255,
256, 265, 266, 269, 270, 272, 277, 279 and 284.
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The commentators also argued that the referral fees prohibition is
inconsistent with the Interagency Statement and the Chubb No-action
Letter, among others. Finally, the commentators stated that the
prohibitions regarding referral fees are inconsistent with the NASD's
long-standing position that ``one-time fees not tied to the completion
of a transaction or the opening of an account'' are permitted.60
Several commentators were also confused about whether the financial
institution and the broker/dealer were both prohibited from paying
referral fees to unregistered employees.61
\60\ In support of its argument that paying referral fees is
acceptable and consistent with the NASD's long-standing position,
the ICI cites NASD Notice to Members 89-3 (January 1993), in which
the NASD proposed, but never adopted, a rule to restrict the payment
of referral fees. The rule change proposed in NTM 89-3 would have
permitted the payment by a member of a small fixed fee for a
referral where the payment is occasional, not part of a practice of
such payments to the recipient, not determined by the outcome of the
referral, and where the recipient does not regularly engage in
activity that might reasonably be expected to result in continued
referrals.
The NASD believes the ICI is incorrect in its assertion that
paying referral fees is acceptable and consistent with the NASD's
longstanding position. Quite to the contrary, the rule change
proposed herein is consistent with that position. The rule proposed
in NTM 89-3 was a codification of the NASD's position that the
payment of referral fees is not permitted, except in very narrow
circumstances. Permitting the payment of referral fees for activity
described in this proposed rule change would not have met the
exception proposed in NTM 89-3.
\61\ See, comment letters 4, 9, 14, 15, 16, 18, 21, 27, 29, 30,
39, 50, 64, 77, 80, 83, 84, 85, 86, 92, 94, 107, 108, 109, 122, 125,
144, 145, 152, 154, 155, 187, 203, 204, 205, 207, 213, 215, 220,
221, 222, 223, 237, 242, 258, 267, 275 and 277.
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Paragraph (c)(7)(B) previously published for comment referred only
to compensation paid by an NASD member. It would not have regulated the
compensation a financial institution may provide to its own employees.
The NASD's longstanding position regarding referral fees has been that
if one-time payments by a member to an unregistered individual occur on
a regular, on-going basis, the recipient is required to register as an
associated person.62 In addition, an NASD member may not do
indirectly what it is prohibited from doing directly, i.e., an NASD
member may not compensate employees of the financial institution for
referrals through payments made directly to the employee or by payments
directed in the first instance to the financial institution.
\62\ See, NASD Guide to Rule Interpretations, 1994 Net Capital
and Customer Protections Rules, p. 108.
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The NASD also believes the commentators misunderstand the meaning
of the ``one-time payment exception'' that has previously been the
policy of the NASD and was reflected in the provision published for
comment. As stated above, the exception does not permit a series of
``one-time payments'' because such a series of payments would become
part of the employee's regular course of business, a circumstance that
would require registration. To meet the requirements of the exception
that has previously been the policy of the NASD, a payment must be a
singularly unusual event; i.e., so infrequent that it cannot be
regarded as part of the regular business or activity of the employee.
In response to the comments received, however, the NASD has
substantively amended the provisions of the original proposed rule
change by clarifying and consolidating them into a single provision,
subsection (c)(3), that prohibits a member from providing compensation
to the employees of a financial institution who are not registered as
associated persons of a member in connection with, but not limited to,
locating, introducing, or referring customers of the financial
institution to the member.
7. Supervision and Responsibility. Paragraph (c)(8)(A) of the
original proposed rules provided that a designated principal of the
member shall supervise registered personnel at the member's location at
the financial
[[Page 11926]]
institution. Several commentators urged the NASD to amend this
provision to clarify that the designated principal deemed to be
responsible for supervising registered personnel at the member's
location at the financial institution is not required to be physically
present at the financial institution location.63 Further,
commentators argued that the provision duplicates existing supervisory
requirements applicable to all NASD members, as set forth in Article
III, Section 27 of the Rules of Fair Practice.
\63\ See, comment letters 17, 21, 27, 28, 64, 77, 121, 129, 138,
140, 156, 177, 181, 192, 234, 242, 245, 267, and 276.
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The ICI argued that the NASD should delete paragraph (c)(8)(C) of
the original proposed rules which required a member to supply financial
institutions with written procedures that specify the limits of the
permissible activities of unregistered persons.64
\64\ See, comment letter 167.
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In response to the commentators, the NASD has determined to delete
paragraph (c)(8) of the original proposed rules in its entirety as
generally redundant of the member's obligations under already existing
NASD rules.
8. Customer Disclosure and Written Acknowledgment. Subsection
(c)(9) of the original proposed rules required a member to obtain a
separate written acknowledgment at the time an account is opened that
the securities products purchased or sold by the member through offices
located on the premises of a financial institution: (1) Are not insured
by the FDIC; (2) are not deposits or other obligations of the financial
institution and are not guaranteed by the financial institution; (3)
are subject to investment risks, including possible loss of the
principal invested; and, (4) are not insured by the Securities Investor
Protection Corporation (``SIPC'') as to the loss of principal amounts
invested.
Several commentators argued that the disclosures required in the
proposed separate written acknowledgment should be made by all broker/
dealers because, as the BSA asserted, investors who purchase securities
through non-financial institution broker/dealers would benefit equally
from these required disclosures, especially non-financial institution
broker/dealers offering insured products.65
\65\ See, comment letters 1, 6, 17, 21, 27, 61, 94, 104, 136,
173, 189, 217, 219 and 230.
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Other commentators stated that a requirement to obtain written
acknowledgment of the disclosures prior to conducting business with a
customer who opens an account by telephone would have an adverse impact
on members that service the financial institution's customers because
many of these accounts are opened by telephone and written
documentation is usually sent to the customer by the broker/dealer
after the account is opened. These commentators proposed that the rule
be amended to permit a member's registered representative to state the
disclosure over the telephone and subsequently forward the written
documentation for execution.66
\66\ See, comment letters 17, 172 and 242.
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Some commentators, including the CBA and BSA, opposed the concept
of requiring a ``separate'' written acknowledgment of the required
disclosures based on their belief that the Interagency Statement
permits these disclosures to appear in the customer agreement or
account application.67 Accordingly, the BSA, the CBA, and other
commentators proposed that the disclosures be a part of a new account
form/account application.68
\67\ See, comment letters 10, 27, 84, 101, 102, 104, 115, 166,
172, 173, 192, 207, 212, 239, 250, 279 and 282.
\68\ See, comment letters 10, 27, 84, 101, 192 and 239.
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A number of the commentators, including the OCC, expressed concerns
about competing disclosures of the NASD and financial institution
regulators, especially when the expenses associated with printing
disclosure documents are considered.69 One commentator, Citicorp
Investment Services, noted that compliance costs for the Interagency
disclosures were in excess of one million dollars, yet the proposed
rule change would require existing materials to be reprinted.70
The commentators urged the NASD to coordinate with financial
institution regulators to adopt one standard disclosure.
\69\ See, comment letters 3, 4, 11, 28, 40, 50, 63, 64, 67, 75,
81, 104, 115, 120, 121, 128, 129, 130, 180, 208, 213, 234, 237, 252
and 279.
\70\ See, comment letter 67.
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Many commentators, including the ICI, OCC, and the FRB, said that
the proposed SIPC disclosure would cause greater confusion than
existing disclosure requirements.71 The commentators argued that
the SIPC disclosure is confusing because it stands alone with no
explanation of SIPC. The OCC and a number of other commentators
recommended that, in the alternative, the NASD should amend the
proposed rule change to require the SIPC disclosure only where sales
activities include representations regarding SIPC. A number of
commentators also expressed their view that the proposed SIPC
disclosure is technically incorrect because the loss of principal
amounts invested is protected where a broker/dealer becomes
insolvent.72 One commentator suggested that the SIPC disclosure be
amended to state that ``losses due to market fluctuation are not
protected by SIPC.'' 73
\71\ See, comment letters 1, 7, 9, 11, 12, 16, 19, 30, 37, 50,
54, 75, 76, 80, 81, 84, 90, 92, 93, 103, 107, 112, 113, 115, 121,
122, 123, 129, 137, 140, 143, 167, 172, 173, 177, 183, 204, 207,
210, 211, 224, 230, 234, 236, 244, 252 and 282.
\72\ See, comment letters 20, 21, 22, 25, 27, 75, 76, 85, 94,
99, 104, 133, 137, 142, 147, 148, 156, 167, 168, 170, 178, 183, 186,
188, 190, 196, 210, 211, 216, 233, 266, 269, 270, 271 and 272.
\73\ See, comment letter 233.
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A large number of commentators also noted that the proposed SIPC
disclosures discriminate among broker/dealers. They argued that if the
SIPC disclosure requirement is to be adopted at all, the disclosures
should apply to all member firms whether operating on financial
institution premises or not; limiting SIPC disclosure to financial
institution broker/ dealers is not only anti-competitive but
misleading.74
\74\ See, comment letters 1, 3, 4, 7, 8, 17, 18, 22, 23, 25, 27,
37, 40, 47, 48, 50, 52, 54, 56, 63, 64, 77, 81, 84, 88, 92, 94, 99,
100, 104, 107, 109, 110, 115, 119, 121, 122, 123, 129, 130, 140,
142, 147, 153, 155, 167, 168, 169, 174, 177, 184, 186, 189, 190,
193, 197, 204, 207, 208, 212, 216, 225, 226, 227, 230, 236, 239,
240, 242, 256, 258, 266, 269, 270, 271 and 279.
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In response to these comments, the NASD has determined to delete
the proposed SIPC disclosure in paragraph (c)(9)(D). The required
disclosure set forth in subsection (c)(4) of the proposed rule change
is now substantively identical to that contained in the Interagency
Statement.
9. Solicitation. Subsection (c)(10) of the original proposed rules
prohibited members from using confidential financial information
maintained by the financial institution to solicit customers for its
broker/dealer services.75 Many of the commentators argued that, to
the extent there are special concerns when a financial institution
provides confidential financial information, the concerns are properly
the subject of financial institution regulation and existing federal
privacy laws, not NASD rulemaking.
\75\ See, comment letters 1, 3, 8, 9, 10, 11, 12, 16, 17, 18,
19, 21, 22, 25, 26, 27, 28, 29, 30, 37, 40, 41, 44, 46, 52, 59, 60,
61, 62, 63, 64, 67, 72, 73, 75, 76, 82, 83, 84, 86, 88, 90, 91, 92,
95, 99, 100, 102, 104, 106, 110, 111, 112, 113, 115, 119, 121, 122,
123, 127, 129, 130, 131, 133, 136, 137, 138, 141, 142, 145, 147,
153, 154, 156, 166, 167, 168, 169, 170, 172, 173, 174, 176, 177,
178, 180, 183, 184, 186, 189, 190, 191, 192, 193, 197, 202, 204,
208, 209, 210, 211, 212, 216, 220, 224, 225, 226, 227, 230, 232,
233, 234, 236, 237, 239, 240, 242, 244, 255, 256, 258, 265, 266,
272, 274, 278, 281, 282 and 294.
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Some commentators who opposed the limitations advised the NASD that
[[Page 11927]]
prohibitions on a member's use of confidential financial information
should apply equally to all broker/dealers. The commentators argued
that there is no public policy reason why customer information
possessed by affiliates of non-financial institution broker/dealers on
real estate holdings, consumer finance loans, insurance, or other
financial matters should be treated differently than customer
information provided by a financial institution.
The commentators asked, however, if the NASD determines to retain
this aspect of the proposed rule change, that the provision be amended
to allow a member's use of confidential financial information where a
customer has approved of such use. In addition, the OCC recommended
that the provision be amended to require members to establish policies
and procedures regarding the use of confidential financial information
instead of banning the use of such information. Many commentators asked
that the term ``confidential financial information'' be defined, if the
NASD retains the provision in the proposed rule change.76
\76\ See, comment letters 13, 16, 17, 18, 21, 22, 24, 26, 29,
31, 32, 37, 38, 39, 45, 47, 54, 56, 72, 74, 79, 80, 81, 85, 108,
110, 111, 112, 118, 119, 121, 127, 128, 129, 130, 131, 132, 135,
138, 144, 146, 147, 148, 151, 157, 165, 169, 182, 183, 187, 188,
189, 190, 192, 193, 194, 198, 201, 205, 206, 216, 220, 221, 224,
231, 239, 240, 241, 243, 246, 251, 259, 263, 271, 276 and 280.
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Finally, some commentators asked how a member could restrict the
use of confidential information where dual employees have access to the
information.77 Another commentator asked that the rule be amended
to permit the financial institution to control abusive use of
confidential financial information where a wholly-owned broker/dealer
subsidiary is involved.78 Another commentator also urged that
sharing confidential information should be permitted where the
financial institution and the broker/dealer are affiliates.79
\77\ See, comment letters 6, 10, 59, 193 and 244.
\78\ See, comment letter 138.
\79\ See, comment letter 94.
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In response to the comments, the proposed rule change has been
amended in subsection (c)(5) under a new heading entitled ``Use of
Confidential Information'' to allow the use of confidential financial
information with the prior written approval of the customer. In
addition, a definition of the term ``confidential financial
information'' has been added to the proposed rule change which provides
that information will not be regarded as confidential if it can be
obtained from unaffiliated credit bureaus or similar companies in the
ordinary course of business.80 Further, a customer's name, address
and telephone number are not confidential information unless the
customer specifies otherwise.
\80\ The NASD has indicated that credit bureaus obtain and
report information concerning the creditworthiness of individuals
such as loan payment histories, checking and savings account
activity, available credit, and total debt information. Similarly,
the NASD staff has stated its belief that credit bureaus do not
maintain net worth information including the value of the customer
assets such as property, depository accounts, certificates of
deposits, securities and other investments. See Letters from Elliott
R. Curzon and Suzanne E. Rothwell, Assistant General Counsel, NASD,
to Mark Barracca, Branch Chief, SEC, note 2, supra.
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10. Communications with the Public. Paragraph (c)(11)(B) of the
original proposed rule change required that all communications
regarding securities transactions and long and short positions,
including confirmations and account statements, must clearly indicate
that the broker/dealer services are provided by the member and not by
the financial institution, and must be sent directly to the customer by
the member. Commentators, including the ICI, ABA, BSA, CBA, FRB, and
the OCC, asked that this provision be amended to permit combined
account statements of a broker/dealer and a financial institution as a
customer service.\81\ These commentators argued that requiring a
separate statement would increase costs, reduce efficiencies and
frustrate consumers. These commentators also noted that the prohibition
is particularly problematic with respect to ``sweep accounts'' and
individual retirement accounts at financial institutions which allow
for investments in securities products offered through an NASD member.
\81\ See, comment letters 15, 23, 26, 28, 30, 31, 35, 39, 40,
42, 43, 46, 47, 48, 53, 54, 56, 58, 69, 71, 75, 76, 77, 78, 80, 83,
86, 110, 115, 116, 117, 119, 122, 123, 124, 126, 127, 128, 129, 131,
135, 136, 140, 143, 145, 146, 148, 152, 156, 158, 159, 162, 163,
167, 184, 186, 187, 188, 189, 190, 192, 194, 199, 200, 201, 205,
207, 224, 233, 239, 241, 243, 245, 246, 248, 251, 276, 279, 280 and
281.
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Paragraph (c)(11)(B) of the original proposed rule change also
required that all communications sent by the member to a customer must
clearly indicate that the broker/dealer services are provided by the
member and not by the financial institution. Several commentators
asserted that requiring the member to disclose that the financial
institution is not the broker/dealer may lead to customer
confusion.\82\ These commentators also asked whether the requirement
that the communication ``clearly indicate that the broker/dealer
services are provided by the member'' requires an affirmative statement
to that effect. Finally, one commentator argued that identifying a
specific financial institution in the disclosure is burdensome where a
member is networking with more than one financial institution.\83\
\82\ See, comment letters 7, 23, 37, 75, 107, 108, 115, 137,
142, 155, 167, 208, 212, 213, 236, 267 and 279.
\83\ See, comment letter 213.
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Finally, paragraph (c)(11)(B) of the original proposed rules also
required the member to ensure that any documentation regarding
securities transactions sent directly to a member's customer by an
issuer, transfer agent, or principal underwriter is in compliance with
the federal securities laws and NASD rules. Several commentators argued
that the member should not be responsible for correspondence from the
issuer, transfer agent, or underwriter, particularly in the absence of
SEC rules requiring these entities to submit such communications to the
NASD member firm for review prior to dissemination.\84\
\84\ See, comment letters 7, 17, 21, 25, 27, 63, 64, 84, 110,
121, 129, 140, 156, 181, 207, 234, 242, 276 and 282.
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One commentator also argued that smaller members may not have the
economic clout to require the issuer, underwriter, and others to submit
such documentation to the member in order to ensure that they comply
with the rules.\85\ Another commentator asserted that ensuring that
documents sent by third parties comply with SEC and NASD rules would
impose strict liability upon members for matters that are often beyond
their knowledge or control.\86\ Another commentator stated that the
rule would make the member liable for misrepresentations appearing in
prospectuses and offering circulars about which the member has no
knowledge.\87\
\85\ See, comment letter 7.
\86\ See, comment letter 25.
\87\ See, comment letter 63.
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In response to the comments received, the proposed rule change has
been amended to permit a joint account statement where the member's
securities products are clearly distinguished from FDIC-insured
products of the financial institution, which is included as paragraph
(c)(6)(A) of the proposed rule change. In addition, the provision has
been amended to delete the requirement for members to ensure the
accuracy of communications sent by third parties.
Paragraph (c)(11)(C) of the original proposed rules provided that
any advertisement or sales literature, as defined in Article III,
Section 35 of the NASD Rules of Fair Practice, used to describe or
promote the availability of broker/dealer services of the member on the
premises of a financial institution
[[Page 11928]]
must be approved by the member prior to distribution, in compliance
with Article III, Section 35(b)(1) and, where required, filed with the
NASD Advertising Regulation Department. Several commentators asserted
that this provision would expand the filing requirements of members
because it would require that all advertisements issued by a financial
institution that mention the member be filed with the NASD.88 The
FRB asserted that the NASD does not need to review financial
institution advertisements that describe products and services offered
by an NASD member because such materials are reviewed by financial
institution regulators to ensure that the materials are accurate and
not misleading.89
\88\ See, comment letters 30, 115, 129 and 211.
\89\ See, comment letter 103.
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In response to the comments received, the NASD has deleted this
provision and substituted more general requirements in paragraphs
(c)(6)(B) and (C) to require that the financial institution may only be
referenced by a member in a non-prominent manner in advertisements,
sales literature or similar materials, and that such material, if
jointly issued by the member and the financial institution, must
distinguish clearly between the products and services offered by the
member and the financial institution.
Paragraph (c)(11)(D) of the original proposed rule provided that
advertisements and sales materials issued by the member which relate
exclusively to its broker/dealer services must indicate prominently
that the broker/dealer services are being provided by the member and
not the financial institution; that the financial institution is not a
registered broker or dealer; and whether the member is or is not
affiliated with the financial institution. The ICI and other
commentators asserted that requiring a member to reference the
financial institution for the sole purpose of complying with this
provision, although the financial institution is not otherwise
affirmatively mentioned, may lead to customer confusion.90 The BSA
and other commentators also argued that stating that the bank is not a
broker/dealer ignores the fact that the bank may be operating as a
broker/dealer exempt from registration under of the 1934 Act. Indeed,
one commentator suggested that stating that the bank is not a broker/
dealer connotes inferiority and misleads the public by implying that
the bank is required to be registered.91 Another commentator noted
that stating that the bank is not a broker/dealer would be inaccurate
with respect to its particular arrangement because the financial
institution in its case operates a bond department which is in fact a
registered broker/dealer.92
\90\ See, comment letters 7, 23, 37, 75, 107, 108, 115, 137,
142, 154, 167, 208, 212 and 279.
\91\ See, comment letter 121.
\92\ See, comment letter 90.
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Some commentators, including the ABA and CBA, stated that no
disclosures should be required beyond what is presently required by the
Interagency Statement (i.e., deposits are not FDIC insured, obligations
of the financial institution or guaranteed by the financial
institution, and involve risks.) 93
\93\ See, comment letters 3, 7, 40, 92, 94, 166, 184, 204 and
239.
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In response to the commentators, the NASD has amended this
provision, now set forth in paragraph (c)(6)(B), to delete the
requirements that members disclose that the financial institution is
not a registered broker/dealer, and whether the member is or is not
affiliated with the financial institution. The provision now requires
disclosure of any material relationship between the member and the
financial institution.
Paragraph (c)(11)(D) of the original proposed rules also permits
advertisements and sales literature issued by the member which relate
exclusively to its broker/dealer services to reference the financial
institution in a non-prominent manner solely for the purpose of
identifying the location where broker/dealer services are available.
The ICI, BSA, CBA, and the FRB said that restrictions on references to
the financial institution may be misleading where the financial
institution acts as an investment adviser to proprietary funds.94
These commentators believe that the restrictions on references to the
financial institution may prevent truthful advertising of the
affiliation between the financial institution and the broker/dealer.
The NASD has modified this requirement, which is now set forth in
paragraph (c)(6)(B) of the proposed rule change, consistent with the
provisions of the Chubb Letter.
\94\ See, comment letters 19, 25, 27, 29, 52, 67, 68, 81, 84,
104, 114, 115, 119, 129, 172, 192, 196, 212 and 245.
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Other commentators stated that the limitations on references to the
financial institution set forth in paragraph (c)(11)(D) are
inconsistent with Article III, Section 35, which allows a member to use
a ``generic name,'' provided that the identity of the member firm and
its relationship to the name are conspicuously set forth.95 The
NASD does not intend for the proposed rule change to modify the ability
of members to rely on Article III, subsection 35(f)(3)(B) to use a
generic name.
\95\ See, comment letters 17, 21 and 242.
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Paragraph (c)(11)(E) of the original proposed rule change permitted
jointly issued material if the name of the member is displayed
prominently in the section of the materials that describes the broker/
dealer services offered by the member, which section will be deemed
material of the member. This concept of segregated advertising,
according to the ICI, the FRB, and other commentators, will prove to be
problematic in practice because it is difficult to physically separate
the discussion of broker/dealer services when the product offered
includes services from both the depository institution and the broker/
dealer.96 In response to these comments, the NASD has amended the
provision set forth in paragraph (c)(6)(C) of the proposed rule change
to require that joint sales materials ``distinguish'' the products of
the member from those of the financial institution.
\96\ See, comment letters 63, 80, 103, 104, 115, 233, 279 and
167.
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Some commentators suggested that the NASD amend paragraph
(c)(11)(E) to provide for introductory letters permitting the financial
institution to introduce financial institution customers to the broker/
dealer.97 The NASD has determined not to amend the proposed rule
change as requested, because it does not believe the proposed rules
currently prohibit such letters.
\97\ See, comment letters 9, 154, 180 and 213.
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Finally, paragraph (c)(11)(D) of the original proposed rules
provided that the financial institution must appear in a non-prominent
manner in advertising relating exclusively to broker/dealer services,
while paragraph (c)(11)(E) of the original proposed rules states that
the name of the member must be displayed prominently in the section of
jointly issued material that describes broker/dealer services offered
by the member. Some commentators asked that the term ``prominently'' be
defined.98 Further, some of these commentators maintained that the
provisions are inherently inconsistent with one another in that they
require the financial institution to appear in a non-prominent manner,
while also requiring the member to disclose that the financial
institution is not a broker/dealer and broker/dealer services are not
offered by the financial institution.99 The NASD has amended these
provisions which are set forth in paragraph (c)(6)(B) and (C)
[[Page 11929]]
by eliminating the provisions which create the apparent inconsistency.
\98\ See, comment letters 80, 135, 140, 181, 213 and 215.
\99\ See, comment letters 1, 27, 84 and 208.
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Some commentators asserted that communications with the public
should be uniform among all broker/dealers if eliminating customer
confusion is truly the NASD's goal.100 The NASD agrees and
believes the proposed rule change advances that goal.
\100\ See, comment letters 48, 63, 66, 84, 129 and 208.
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D. Financial Institution Logos. While the proposed rule change does
not specifically address the issue of the use of financial institution
logos in advertisements and sales literature, several commentators,
including the FRB, asked the NASD to clarify its position on the use on
financial institution logos by NASD members to dispel any confusion
about the permissibility of using financial institution holding company
family logos. The FRB urged the NASD to permit the broker/dealer to use
an affiliated financial institution logo to advertise its
services.101 Subsequent to the publication of Notice to Members
94-94, the NASD issued Notice to Members 95-49 to clarify its previous
statements on the use of logos of financial institutions in
advertisements and sales literature of members in a manner consistent
with the Chubb Letter. The Notice stated that the logo of a non-member
(representative only of the non-member) may only be used in member
communications to identify the non-member entity.
\101\ See, comment letters 11, 85, 103, 121, 140, 184, 189, 191,
216, 234, and 282.
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III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
The NASD consents to an extension of the time for Commission action
to 30 days from the end of the comment period specified in Item IV
below. At such time, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to the file number in the caption
above and should be submitted by May 21, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.102
\102\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-6970 Filed 3-21-96; 8:45 am]
BILLING CODE 8010-01-P
